UK: The New Commercial Lease Code

Last Updated: 4 October 2002
The new Code of practice for commercial leases in England & Wales was Launched on 22nd April 2002 – What does it mean to you?

Background

The Code is a voluntary Code. It replaces the first Code launched in 1995.

The 1995 Code was (like the new Code) produced by a cross-industry group representing landlords, tenants and the professional advisors, and it aimed to promote flexibility and openness in the landlord and tenant relationship on a voluntary basis - rather than having it policed by law. At that time many tenants were disappointed with the government’s decision not to intervene, particularly on the issue of upward only rent reviews.

The DoE said that it would lead by example whenever government departments took or let accommodation and that it would be monitoring the effect of the Code on the property market.

The 1995 Code was largely ignored.

Successive governments have been concerned about the inequality of bargaining power between landlords and tenants. Tenants were, on the whole, disadvantaged when negotiating leases. Although market forces have produced some changes sought by the government, such as shorter leases, and the use of break clauses, the changes did not satisfy the government. The government threatened legislation to regulate leases (with particular reference to upward only rent reviews) and, under this threat, the property industry revised the voluntary 1995 Code finding compromises acceptable to the different sides of the property industry.

This time the government has made it known that it intends to monitor the effectiveness of the Code over the next two years and, if the Code is not adopted voluntarily, legislation will be considered.

Take-up
It is difficult to judge the take-up of the Code - not least because neither the RICS or the BPF maintain a list of the companies who have publicly subscribed to the Code.

Certain of the big players are known to have subscribed to the Code. Although it is early days, it is unclear whether, despite the statement by the working party that the Code reflects “best practice”, the Code will find favour with the property industry.

Market forces may push landlords and tenants towards the recommendations contained in the Code but it will need a clear effort to persuade the property industry at large that the Code is a “good thing”.

Monitoring the Code
The DTLR is to set up and operate a complaints system for non-compliance. The RICS and the BPF have both devised forms that they will encourage their members to complete with a view to judging the take-up of the Code. They need to agree between themselves (and the Law Society) as to how the forms will be used.


Main messages of the Code
Flexibility - in negotiations landlords should, where possible, offer tenants a choice of terms including term of lease, upward or downward rent reviews, repairing liability.

Tenant awareness - tenants should be encouraged to take professional advice on property issues at an early stage both in negotiations and during the term of the lease.

Openness - both parties to the lease should deal with each other constructively, courteously, openly and honestly.


Negotiation of new leases

The key recommendations are as follows:-

  • Duration of the lease - landlords should consider offering tenants the choice and length of the term, including break clauses where appropriate and with or without protection of the Landlord & Tenant Act 1954.

    Where alternative lease terms are offered, different rents should be appropriately priced for each set of terms.

    Those funding property should make every effort to avoid imposing restrictions on the length of the lease, landlords, developers and/or investors they offer.

  • Rent review - the basis of rent review should generally be to an open market rent. Where possible landlords should offer alternatives which are priced on a risk adjusted basis including alternatives to upwards only rent reviews. The alternatives might include upward or downward rent reviews to market rent with a minimum of the initial rent or another basis such as annual indexation.

    Again those funding property should make every effort to avoid imposing restrictions on the type of rent review that landlords/developers and/or investors should offer.

  • Repairs and services - the tenant’s repairing obligations and any service charges should be appropriate to the length of the term and condition and age of the property at the start of the lease. Again, where appropriate, landlords are directed to consider appropriately priced alternatives to full repairing terms.

  • Insurance - two points arise:

    • The tenant of an entire building should in appropriate cases be given the opportunity to influence the choice of insurers; and

    • If the premises are so damaged by an uninsured risk so as to prevent occupation, the tenant should be allowed to terminate the lease unless the landlord agrees to rebuild at its own cost.

    The explanatory note to the Code also states that the lease should contain provisions governing the situation where there is a large insurance excess. There is no explanation of what the drafters of the Code have in mind.

  • Assignment and subletting - unless particular circumstances of letting justify greater control, the only restriction on assignment of whole premises should be the obtaining of a landlord’s consent, which is not to be unreasonably withheld.

    There is no explanation of what the particular circumstances are. However it is acknowledged in the guidance notes that a new lease may expand the landlord’s right to control assignments by imposing credit ratings or other financial criteria for assignees.

    With regard to authorised guarantee agreements, landlords are urged to consider requiring AGAs only when the assignee is of lower financial standing than the assignor at the date of the assignment. This implies that an AGA should not automatically be required.

  • Alterations and changes of use - the landlord’s control over alterations and change of use should not be more restrictive than is necessary to protect the value of the premises and adjoining premises owned by the landlord.

    There is a recommendation that at the end of the lease, the tenant should not be required to remove or make good permitted alterations unless it is reasonably required.


Directions to the parties
The Explanatory Notes to the Code indicate that;
  • the terms of the lease should reflect the type, location and condition of the property, the need and status of the parties and the state of the property market and that all the terms of the commercial lease are normally negotiable.

    The guide emphasises that the appropriate level of rent will depend on, amongst other things, the terms on which the lease is to be granted, especially the burden of the repairing covenant.

  • the direction is that the landlord and tenant should have regard to the Code’s recommendations when negotiating lease renewals. It is accepted that if the court has to fix new terms, the court is not bound by the Code.


Recommendations governing the ongoing relationship between the parties during the course of the lease

The recommendations are aimed at encouraging the parties to act reasonably and with openness towards each other. As such, they represent a move towards a degree of openness which is reflected in a “service provider” orientation as opposed to the traditional landlord/tenant relationship.

They are summarised as follows:-

  • an open and honest ongoing relationship - where if either party proposes to take any action which is likely to have significant consequences for the other, that party proposing the action, when it becomes appropriate so to do, should notify the other without undue delay;

  • requests for consents - the tenant should provide full information to the landlord when it seeks consent for any action required under the lease and the landlord should respond without undue delay. The landlord should also ensure that the request is promptly passed to any superior landlord or mortgagee whose agreement is required and should give details to the tenant so that any problems can be speedily resolved;

  • rent review negotiation - both parties should understand the basis on which the rent may be reviewed and the procedure to be followed. They should seek professional advice on these matters well before the review date;

  • insurance - the terms of any insurance effected by the landlord must be notified to the tenant and any interests of the tenant be covered by the policy. Any material change in insurance should be notified to the tenant;

  • varying the lease - effect on guarantors - guarantors should be involved with any material variations to the lease and with any minor changes that could increase the guarantor’s liability;

  • former tenants and their guarantors - where previous tenants or their guarantors are liable to the landlord for defaults by the current tenant, landlords should notify them before the current tenant accumulates excessive liability. All defaults should be handled with speed and the landlord should seek to assist the tenant and the guarantor in minimising losses;

  • release of the landlord on the sale of the property - it is recognised that this may be a point that the landlord may wish to seek legal advice on;

  • repairs - the tenant should take advice from a property professional on their repairing obligations near the end of the term of the lease and immediately upon receiving notice to repair or a schedule of dilapidations;

  • business rates - it is point out that the tenants or other ratepayers should need to consider whether their business rate assessment is correct or whether they need to appeal;

  • service charges - landlords are directed to observe the Guide to Good Practice on Service Charges in Commercial Properties. Tenants are directed to take professional advice if they are being asked to pay excessive service charges;

  • dispute resolution - where disputes arise, the parties should make prompt and reasonable efforts to settle them by agreement. Mediation may be appropriate before embarking on more formal procedures;

  • repossession by the landlord - it is stated that the landlord should be clear about their rights before attempting to operate a forfeiture clause and may need professional advice;

  • renewals under the Landlord & Tenant Act 1954 - it is recommended that the parties should take professional advice on the operation of the 1954 Act.
As you will see, all these recommendations are commonsense and do not do anything other than guide a tenant towards the Code and the professionals.


Issues
  • Landlords
    The question is whether they should adopt the Code. There will only be two drivers here:-
    • market forces;
    • the threat of statutory legislation.
    If a landlord decides to adopt the Code, it will have to decide whether:
    • it will need to adjust its letting policy to comply with the Code;
    • its lease terms comply with the Code; and
    • its management procedures and policies comply with the Code during the term of the lease.
    If a landlord adopts the Code, that landlord will have to inform its professional advisors if it wishes to “cherry pick” some recommendations - rejecting others.

  • Tenants
    A tenant has to establish whether or not the landlord with whom it is negotiating has accepted the Code. If the landlord has adopted the Code, the tenant should use this to its advantage in negotiations on the commercial aspects of the letting and on the terms of the lease itself.

  • Funders
    Funders should be aware of the fact that a landlord/investor (whether or not it has formally adopted the Code) may wish to ensure that the terms of any mortgage allow it to have the flexibility that the Code recommends. You will see that the wording of the recommendations is that those funding property should make every effort to avoid restricting the landlord’s freedom in letting premises in certain respects.


The full text of the Code is available on the following website:-
http://www.commercialleasecodeew.co.uk

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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